Written by a human
In 2024, cryptocurrency investment company Abra was charged with operating for more than two years without registering as an investment company. This came after the company issued securities to the public and held more than 40% of its assets, equating to over $600 million, in investment securities.
Combined with other regulatory failures, Abra was charged with an injunction prohibiting the violation of the Investment Company Act and civil financial penalties.
What is the Investment Company Act?
The Investment Company Act of 1940 regulates how investment companies may operate, the activities their affiliated persons can get involved in, and what information they must disclose.
It was introduced to provide a framework around how companies must be structured and to create minimum standards across the industry. By tightening regulations and requiring all eligible investment companies to register with the SEC, investors would inevitably become better informed and protected over their financial decisions.
Investment Company Act vs. Investment Advisers Act
The Investment Company Act was brought in at the same time as the Investment Advisers Act, with both following the Securities Exchange Act (1934). The Securities Act and Investment regulations were established after the devastating economic crash of 1929, which left many investors with nothing and caused mass distrust in the financial markets.
Thus, understanding the differences between each 1940 act for investments is important in order to understand key focuses.
Investment advisers are in charge of providing guidance on financial decisions. Under fiduciary duty requirements, they must complete their due diligence to tailor guidance specifically to their client.
Alternatively, investment companies are those responsible for making and overseeing investments by trading securities, following securities law, and the Investment Company financial regulation.
Rules of the Investment Company Act
The Investment Company Act defines what constitutes an investment company, as well as sets out recordkeeping requirements.
Investment Company Definition
Regulation requires that all “investment companies” register with the SEC before they can offer securities to their investors or provide investment advice.
Investment companies are defined as:
“A corporation, business trust, partnership or limited liability company that issues securities and is primarily engaged in the business of investing in securities. An investment company invests the money it receives from investors on a collective basis, and each investor shares in the profits and losses in proportion to the investor's interest in the investment company.”
To check whether your company falls under this definition, review the five–point Tonopah test:
- What percentage of assets is composed of investment securities?
- What percentage of income is derived from investment securities?
- What are the activities of officers and directors?
- What do the public statements, including SEC filings, press releases and disclosures say?
- What is the history in terms of development and activities?
In general, if a company holds at least 40% of its assets or income in securities, it should be a registered Investment Company (although there are some exceptions).
Recordkeeping requirements
The recordkeeping requirements of the Investment Company Act exist as part of an accountability strategy, ensuring that all actions and communications are traceable.
Investment companies are required to keep records of their accounting methodologies, investment and fund distributions, and responses to suspicious activities. This involves noting financial disclosures, fiduciary duties, each affiliated person (like an investment adviser), filings, and service charges.
Eligible companies are also required to inform the public and the SEC of their investment policy, investment objective, and financial condition upon the sale of stock or asset and the company’s structure.
Staying on the right side of the SEC
Between 1994 and 2018, Great Plains held over $480 million in 18 different retirement trusts. Though, the company allegedly failed to register these securities of trust funds.
It’s unclear whether Great Plains’ directors believed they qualified for an exemption from registering. However, the SEC’s case makes clear that they were ineligible, since Great Plains advertised to the public and did not solely use their securities to aid the administration of the trust.
In combination with other failings, the company was fined $300,000 and received a cease-and-desist order from the SEC.
With the regulator laser focused on enforcing its legislations, investment companies can’t afford to make the wrong move. Conduct a regulatory review to confirm you remain on the right side of the SEC, and partner with Global Relay to ensure that your recordkeeping standards are up to par with compliance requirements.